1. Pros of an LLC
2. Cons of an LLC
3. Pros of an S-Corporation
4. Cons of an S-Corporation
5. How to Choose Between an S-Corp. and an LLC

Understanding the difference between S-corp. and LLC, or Limited Liability Company, can help you make the best choice for the type of business you want to form. 

Pros of an LLC

Advantages of operating an LLC include the following:

  • LLC owners report business finances as part of their personal tax returns, so they don't file a business tax return.
  • Single-member LLCs are very easy to create and generally only require a single-page form for setup.
  • You might only need a couple hundred dollars to set up an LLC as they're inexpensive to create.
  • You'll likely save money on attorney and accountant fees because you have less red tape to deal with in creating an LLC.

Cons of an LLC

Some disadvantages of operating an LLC include these:

  • As a single-member LLC, you're responsible for paying estimated self-employment taxes on the business income, payable each quarter to the IRS.
  • You have to be careful to maintain the "corporate veil," or keep your personal affairs completely separate from business affairs.
  • Your LLC has to be an actual operating entity, not just a business shell.
  • If you fail to keep your business and personal affairs separate, you run the risk of losing protection from personal liability.

Pros of an S-Corporation

The biggest advantage of operating an S-corporation is the enjoyment of tax benefits in relation to excess profits, which are also known as distributions.

An S-corp. pays a reasonable salary to its employees. This salary should fall under industry norms, and the usual expenses such as federal taxes and FICA will be deducted. Remaining profits are distributed as dividends to the owners. These dividends aren't taxed at the same rate as income, as dividend taxes are lower.

Cons of an S-Corporation

There are some distinct disadvantages to operating an S-Corp. You have stricter guidelines to adhere to when creating an S-corp, and these include: 

  • Anyone forming an S-corp. has to be a citizen or resident of the U.S.
  • S-corps have a limited number of shareholders (spouses count as separate shareholders).
  • The company can only hold one class of stock.
  • You must distribute profits and losses in proportion to shareholder interest.

It's more expensive to form an S-corp. Shareholders run the risk of giving up the S-corp. designation if they fail to adhere to the guidelines, and the company could then be treated as a C-corporation, along with corresponding restrictions.

No more than 25% of gross receipts can come from passive activities, including investing in real estate, and S-corps may have additional taxes to pay, such as state tax. Shareholders have to take care in paying “reasonable" salaries for their work, as the IRS will carefully scrutinize companies for this.

How to Choose Between an S-Corp. and an LLC

When deciding on the type of business entity you want to form, think about how you want your business to unfold and grow over the years. Also consider the nature of your business.

It might be a good idea to form a C-corp and then choose the S-corp. tax election if you want any of the following: 

  • The maximum protection for personal assets.
  • To get substantial investments from outside parties.
  • To become a publicly traded company that sells common stock.

S-corps begin as other business types, including LLCs, C-corps, or sole proprietorships. For tax purposes, they then choose to become an S-corp.

For someone whose main concern is flexibility in how to manage a business, an LLC is the appropriate option. LLCs are ideal for owners interested in the following: 

  • No plans to make the company public and to sell stock in it.
  • Avoiding all but the minimum amount of corporate paperwork.

Someone who prefers a small and simple business structure is better off forming an LLC, which he or she can manage more personally. Larger, more complex businesses, such as a major financial services firm, will do better as an S-corporation.

Once you understand the pros and cons of different types of businesses, you'll be able to narrow down your decision on the structure you should choose. Carefully weigh all aspects instead of choosing one based simply on tax benefits. Anyone who wants to avoid a lot of red tape and complexity may be fine with a simple LLC.

If you need help with deciding between LLCs and S-corporations, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.